Welcome to Passive Real Estate Investing. I’m your host, Marco Santarelli. Well, today I wanted to bring back a good friend of mine, Mr. Aaron Chapman. He is a 24 year veteran, as in like 1997. That’s how long he’s been in the finance industry. He’s focused on real estate investors and doing investment loans. That is his core expertise. He has a great team. The last count I had was 11 staff members. That’s probably grown at this point, but him and his team, that’s all they do is they work with real estate investors to finance investment property. He’s a great guy, sharp dude, as I like to call him. He likes to follow what’s going on in the mortgage market and the market in general. He talks about inflation. He likes to talk about how to finance intelligently even with rising interest rates. And so those are some of the things that we’re gonna talk about today. None of this is scripted. This is all on the fly off the cuff, him and I just thought let’s just get on and record a podcast episode to talk about the state of the market and how to proceed in today’s environment. And I don’t even have questions written down for him. So we’re just gonna see where this goes.
FREE copy of The Ultimate Guide to Passive Real Estate Investing.
If you missed our last episode, be sure to listen to Ask Marco – Too Many Properties for a 1031 Exchange, Buy a Home or Rental First, Building an Acquisitions Team, Fast-tracking
Aaron, welcome back to the show.
Thanks brother. I did notice it’s gotta be a long time since I’ve been on here, cuz when you said you had 11 staff members down, we’re at 32 now, so it’s been, it’s been a while. <Laugh>.
Okay, well you’re right. So it’s been a while. Either that or are you ramping?
There was, I ran at 11 for, for God, it had to be like 6 or 8 months to a year. And then we just start finding the 11 was not enough. And we keep adding, keep adding, keep adding. Now we got quite the, quite the process and quite the group.
Well, growth is good. That’s good. So you must be doing a lot of loans then.
We are, we’ve done as much as averaging about 125 a month. It’s not that high right now, but it’s still high enough that I get recruiters calling me all the time saying, Hey, you’re one of the few out there. Still getting a lot done. We’re still doing quite a bit of business a lot of business. In fact, I got a call, obviously you ever heard of an outfit called Modex. They called me up to to, to interview me as the number one loan originator in the state of Arizona and like number six or seven in the United States for the transactions closed over the last 12 running months. Like where the hell did that come from? And they, they track everybody who does loans, whether you’re a licensed loan originator, you work at a bank. And they said there’s 1.4 million people out there and that are doing this. And that’s where I sit amongst them, which was pretty amazing to hear. I don’t pay attention to it. So it kind of threw me back a little bit.
So anyone listening to this right now is hearing two things. One, you’re growing, which means you’re doing more loans even with the rising rates, you know, as the backdrop. So let’s talk about that. Let’s probably a good starting point. We’ve seen mortgage rates more than double since the beginning of the year. In January we were at sub 3% for a 30 or fixed conventional loan. You know, you can fill in any of the gaps here, but today we’re more than double that. And so people are asking the question, you know, does it still make sense to get a mortgage loan to invest in real estate with financing? And if I use leverage, how much and do the numbers pencil out? I mean, I’m throwing a lot at you here. Obviously we can break this down into multiple questions, but that’s probably one of the main questions people are thinking as they’re listening to this and they wanna know what your thoughts and opinion is. So let’s just throw it out on the table and just see what we come up with.
Well, that, that stack of questions is not uncommon for me to get, I get it all the time. People wanna invest. They wanna do something. They, they’re not, they’re not secure with what’s going on in the market. They, they know that real estate, where’s most millionaires are made, but the majority of people got into the market during a time that is unprecedented. You know, you’re, you’re talking about mortgage rates going from in the, in the low twos for the owner occupied buyer. Now into the sevens. That is a huge jump and people are having a hard time wrapping the head around, what do we do in this high interest rate environment? It’s like, well let’s talk about interest rates for just a little bit of a moment here and understand the history of interest rates. I’ve got a chart that has 2000, let me see here – 2,695 lines on it that shows every interest rate for every month going back to 1971 for the 30 year fixed. And the average interest rate that it shows for just from 1971 to 2009 for the average home buyer, just a person buying a house to live in, getting a 30 year fixed was 9.11%. Then who you get you factor in from 1971 to 2022, mid 2022. This was up until July to a 7.769. It’s higher than that. Now. We’re approaching probably 7.77 or 7.78 when you look at what’s happening with rates since then. So what I explain to people is when you start looking at what happened here for the last 13 years, everybody talks about market cycles. We didn’t have the market cycles you’d normally have. You’d never normally have one every five to seven years is what what is commonly talked about. But we had 13 years of ridiculously low rates, all because of Fed Reserve dumped in $8.9 trillion into the bond markets to keep rates artificially low.
So who follows along with that? We know that the Bank of England, we got China, we got Japan, we have other corporations, we have investors. Everybody’s throwing money into those same pools cuz the Fed did. Well then what the Fed would do is every time they throw in more money and then they get paid back, right? Somebody refinances a loan or make their payments and they’re making the return on that investment cuz it’s a, it’s a, it’s a it’s a cash flowing investment in reality. They just reinvest the capital and keep growing what they invested into it. They stopped doing that this year. Well, it went from 8.9 trillion to like 8.7 trillion in change. And our interest rates more than doubled. Well, they’re saying they’re gonna continue to taper back from that and have talked about aggressive tapering. What happens if they do aggressive tapering to cut that in half from 8.9 children’s state, 4.5 trillion or something?
Then what happens? Right? It gets really ugly at that point if we’ve already seen this kind of, kind of rates. Now also looking at our state of inflation inflation is because there’s way too much money out there. I think 40% of the u of the, the currency in flux right now has been created in the last 18 months. 18, 19 months. Well, it means there’s way too many dollars out there chasing way too few items, especially with, with supply chain issues and, and labor issues and all these things we’re dealing with because of that inflation is the levels beyond what they were in the, in the early eighties when it’s always been, been labeled to be the worst time for inflation. But the interest rates back then were 18, 19%. The federal fund rate achieved as high as 20% under the direction of Paul Volker, the, the Fed chairman at that time.
He, we had seen rent rate raises of over 4% in one month. We haven’t seen that. We’ve not seen the kind of craziness that could occur. So what I explain to people right now is who they’re talking about interest rates being so high, it’s like you gotta understand what a high interest rate really is. What we have today is still lower for the real estate investor than what the average rate has been for the average homeowner since 1971. Mm-Hmm <affirmative>. So you’re still getting a low interest rate. I’m gonna bust the balls of every person selling real estate right now. Anybody who’s been involved in turnkey, anybody who’s pedaled turnkey, anybody who’s sold real estate investments, prepare for a little bit of a flick in the nuts right here because of this. Everybody sold cash on cash return, like it was the greatest thing in the world for the last 10, 12 years.
Cash on cash return. I’ve been preaching. Anybody who’s seen me present is the smallest equation in the metric of where your real value is in your real estate. And because of that chick and sorry, but it’s the chicken way to sell stuff because of that approach. Selling cash on cash return cuz it was so easy for so long, you’re now paid yourself in this corner to how else are you gonna sell this deal. So now what do you gotta do? You gotta hunt around for different lenders. Who’s gonna cut their costs? Who’s gonna cut their rate? Who’s gonna make this deal better for me so I can sell my cash on cash return? It’s time for you guys to nut the hell up and figure out how to sell some real estate that really generates wealth. Where cash on cash return is not the focus metric. That’s the cherry on the sundae. The sundae’s built with everything else associated with the deal. There’s massive deals out there and the person who’s the pedestrian or the spectator sitting in the stands, they’ll screen cash on cash and now it’s not a good time. But the people on the field who know what’s real and who know where the real value of real estate is, they’re on the field playing and in five years from now, they’re gonna look like geniuses.
Yeah. So there’s a lot to peel back there. A lot of what I’m hearing and seeing and reading is related to the Fed becoming a little bit more dovish and you know, kind of letting go on the breaks and starting to become a little bit more, let’s just say that the days are numbered as far as how long the Fed can possibly be tightening. And so when they start to ease and provide more liquidity and credit, we’re gonna see the Fed funds rates come down and we’re gonna see mortgage rates start to come down as well. And so this will turn around and I don’t know when that’s gonna happen. My prediction is probably six to 12 months from now. It could be sooner, but I don’t suspect, and I like your thoughts on this, I don’t suspect that we’re gonna see continued rising interest rates and mortgage rates over the next six to 12 months. I mean, we might see another two bumps upward, but what’s your perspective? Cuz I have a feeling that we’re probably gonna get back into a, a place where we’re gonna have looser credit because we cannot continue and sustain economic growth on this path of tightening with credit.
So, and that, that’s a really, really interesting question to have to get deeper into because you’ve got a really interesting dynamic here when it comes to what the Fed, Yeah, they’re probably going to only tighten a couple more times as far as raising the federal fund rate from understand three quarters, maybe another three quarters is, is in the, in the the work. But understand that has very, very little to do with the actual interest rates that we’re getting. That’s to slow down inflation. And inflation is the, is the enemy, enemy of bonds. So where our money comes from to lend on interest rates, at least our interest rates come from and where the money comes that we lend out to people buying houses. Cuz I I’m do the, I’m the conventional lender. I’m not your your hard money guy. I’m not your your commercial guy.
I’m the conventional s all the banks out there that do conventional loans for a real estate investor suck at it. So I carved out a niche. Now there’s a few guys out there that are really good. I’m not trying to bust everybody’s balls, but for the, the general population of lenders, they focus on first time home buyers and homeowners. Let them go do that and refis. Investors is a really, really specialized space. Well because of that money comes from all this capital, Wall Street investment capital, other countries, other banks, banks that take money on deposit, they gotta park it somewhere where it’s gonna make money while they’re, while they’re you know, keep paying you your little tiny pits in your, in your account. They will buy mortgage-backed securities. They’ll buy true T bills, stuff like that. Well, with the Fed being the largest buyer of that for the longest period of time utilizing dollars created by the US Treasury and now they’re tapering back from that, I don’t know, and I don’t believe they’re gonna go back into that practice if they don’t go into that practice.
Mortgage rates can continue to rise regardless of what the Fed does with the federal fund rate to curb inflation. Inflation is, and the way that that’s the enemy to bonds is when you take your money and you park it somewhere, let’s just say today’s interest rates. Somebody’s gonna, let’s say a a, a big investor or hedge fund walked in and says we’re gonna buy a hundred or yeah, a hundred billion dollars in mortgage backed securities. Well the rate that they get back based on today’s coupon, you may be getting offered like a 7.5% rate. And that’s not a quote guys, that’s just me throwing a number out there, not quoting you rates. But that’s gonna come off scale like the 5.5 or the 6% and probably the 5.5 coupon is what that’s gonna come off of. That means they’re gonna make five and a half percent return on their investment for the entire 30 years if you keep that loan for 30 years.
But inflation right now, according to the Fed, the CPI is what, 8.4, 8.5%? Well, they’re already at a 3% loss right there. They’re losing that much. So there’s points being charged right now. People are gonna pay points on every deal. There’s a couple points being being floated to them right outta the gate that’s incentivizing people coming to the markets, that kind of stuff. But ultimately they are locking their money up for a long period of time making less than what the burn rate is on the dollars value. What makes us think that they’re gonna wanna keep playing in that environment until we get the rates higher? They need the rates to go higher for them to at least break inflation. So that’s where I think that there is this, there’s this strange dynamic that I can’t say how it’s gonna work out. I can see us potentially going into double digits on real estate on, on, yeah. For real estate investors on a 30 year fixed until we get inflation well under control and people being willing to invest their money into a long term security that’s gonna pay them such a small return.
There’s a lot of dynamics in play right now. There’s this effort towards demand destruction, which is happening in certain industries that will help curb inflation. There is increasing rates across the board, which is starting to change the rate of inflation. In fact, the trend has reversed. I many say that we’ve reached peak inflation and now we’re starting to inch our way down and that could potentially accelerate. I don’t have crystal ball neither do you. We don’t know. But if you look at recent history and the trend, it seems that we’ve reached peak inflation and we’re starting to trend downward. If that’s a continuing trend, then you know, what you’re saying is probably not going unfold. You know, we’re not gonna see continued rising interest rates. It’ll, they’ll taper off and at some point maybe come back down. The thing is is it’s not good for the government to have high interest rates given the debt low that they carry because they need to start servicing that, that debt. We’re reaching a point where it’s gonna cost us a trillion dollars a year. Us as in the country to service the debt that the federal government carries. You know, the higher the rate, the more expensive it is and the less the government can afford it. And that just becomes, you know, an economic disaster. So I think there’s a need for lower rates on multiple levels, economic and political and otherwise.
And I, I don’t disagree with any of that perspective. The thing of it is, is you know, when you heard Jerome Powell and what he had to say in very, very recent months is, is the one thing we know about inflation is we know very little about inflation. Yeah. the other thing is when you look at the, the resumes of all the people in the Fed right now that are making decisions, all the fed their resume, almost all of them starts with when they come outta college the Fed, they know nothing but the Fed and then there’s I think four or five of ’em that they were educators prior to coming to the, coming to the Fed. We we’re not dealing with people to understand the ramifications of decisions on a micro level, especially when it happens to the street. So because of that, I’m not encouraged by their decision making skills.
And so what we’re talking about here, yes I agree that they’re going to try in some way manipulate things to keep it from them having to pay an excessive amount in monthly service or annual service or whatever that is for the, for the national debt. We’re also dealing with the side of admit. I mean we get into the political side of it that seems like they’re held bent on the destruction of everything. And then you’ve got the fact that people don’t understand what they’re even doing and what the ramifications of our, their decisions. I can’t say how it’s gonna end up. The one thing I do tell everybody over and over and over again constantly is control what you can control for as long as you can control it. I know what I can get you today for 30 or fixed. I don’t know what tomorrow or the next year seven years from now is gonna bring.
So when you call me up and says, Hey, I would love to have a seven year arm because it’s gonna be a slightly lower interest rate, I’m gonna tell you I have no idea what’s gonna happen seven years from now. Warren Buffett says that the 30 year fixed is the greatest instrument, financial instrument in existence because it’s a one-way bet. If you’re wrong then you refinance big deal. But if you’re right, you protected yourself from a massive mess that could be looming overhead five, six years from now. If cycles go in every five and seven years and we’re just barely stepping into the first year of this crazy cycle after 13 years of stupidity, how long is this cycle gonna last?
I don’t know. You know, to take that even further about the concept of inflation, you know, the government likes inflation because it devalues the debt that is owed. And so they’re paying their debt down with, you know, deflated dollars each and every year. So hundred percent, you know, it becomes a good deal for them because they’re paying off their debt with cheaper and cheaper dollars. But the important thing about that is this, that is also true for us as real estate investors locking in and getting a 30 year fixed rate mortgage. Well any mortgage for that matter. But if you have a fixed rate loan and you lock that in and you’re in an inflationary environment, which we always have been and for the most part and we will continue to be, that’s good for us because every year that loan becomes worth less because inflation is devaluing the value of that loan and you’re paying it off with cheaper and cheaper dollars on top of that, you’ve locked into a fixed monthly payment. So it’s a good deal. It’s a good deal for us as real estate investors in an inflationary environment to lock in to a 30 year fixed rate mortgage or any kind of even a 15 year or whatever it is. So inflation can be our friend.
Yep. Any long term lock and anybody who’s having a hard time with that concept, grab your phone right now. This is one time I’m gonna tell a person to pick up their phone and put it in front of their face while they’re, while they’re listening to a podcast that I’m on. And go to your app store and search for the Q J O investment tool. The quit jerking off investment tool is what I call it. Cause you’re gonna find it under Q J O and it’s gonna pop up get, it should pop up pretty quickly. You download this on the, the third calculator calculator on here. We’ll show you exactly how this works. And so as you’re talking, I pulled up, if I had to do a loan on a $200,000 house with 20% down at 8% interest rate today, I would pay $422,000 in payments over 30 years.
But because what Marco just said, the value of the dollar declines every, I mean basically every day it’s declining. So at today’s rate of inflation, it’s over 0.66, 6% per month that it’s losing value. When you recalculate every dollar you pay over the next 360 months unit pay four 22,000, the actual value of all of those dollars was $160,000. Look at the calculator, if you’ll under understand how to use it, reach out to me, I’ll guide you through it. But that right there is just what was just described as the most powerful thing in real estate investing. The leverage and the long term lock of the financing and securing your costs for long period of time, not cash on cash return. That will come with rent raises. We can get into that in a minute, but ultimately that’s what’s gonna create your wealth, not anything else.
So on that note, you know we were talking about trends. Let me ask you this question, What trend do you forecast, see or predict in terms of the mortgage rates and inflation rates? We’re kind of tying a bow on this inflation topic here.
So I think that we’re going to probably continue to see rates, interest rates rise a bit. We might be knocking on on double digits. I don’t know. We’ll get there. We could, but we’re gonna be knocking on that. It’s really an oversold market. There’s gonna come a point where people are gonna come back into it. We’re gonna start drawing ventures in. But I think we need to start seeing a little more stabilization in some of the other economies across the globe before you start seeing that, you know, cause a lot of unstable instability in Europe and Japan and China because that instability of their currencies and their, their total market. A lot of our money’s flowing out of it. The other thing that we’re probably are going to hopefully find that bottom and be able to come up off of that and start getting our rates stabilized.
The other thing is, is if the Fed continues to raise, it’s gonna eventually start slowing things down. Inflation’s gonna start getting under control cuz people are gonna stop buying crap. They have to make it more expensive for you to buy something. And right now it’s just not expensive enough cuz everybody still has too much money. Not everybody, I know there’s some people listening to this saying, Dude, I’m hand to mouth right now, I get it, but it’s coming. You’re gonna have to, there’s gonna become a point where people will kind of calm down. The consuming. The one thing I am encouraged by though is the housing market. We’re 5.2 million units short when it comes to housing and as a result of that we’re gonna still see rents rights. You know, our average rental increase, from what I understand year over year is 12%. I don’t know that that will continue. I don’t know that 12% is sustainable nationally. There are some markets who can still be very high. There can be some markets very low. But I think if you’re gonna run your numbers run at about five, that should be very sustainable and see what that year over year increase is gonna do to your cash flow year five, six, and seven instead of worrying about year one, two, and three.
Aaron, what, what should real estate investors be aware of or concerned with for the coming year? I mean we’re, you know, on the cusp of 2023, what, what should investors be aware of and what should they be concerned about?
The create, there’s a few things but the creation of really interesting loans to get their attention and bring them in to get loans done with different banks. Banks are creating stuff to get people attention right now. Cause rates are high on the 30 year fixed when they’re going to Fannie Freddy and your regular conventional channels. So they’re gonna get do in that creativity is what sparked what happened in 2008. And I know there’s a lot of people that’s like, man these other cooler little loans are really attractive guys. Those are not new. Those things were out there in 2008. There’s being repackaged and renamed and I saw a lot of people get hurt. That’s the benefit of working with somebody like myself that’s been at this since 97. I’ve seen people get hurt. I actually wrote the deals that made people bleed. I refuse to write those deals.
Now I stick with, I know is gonna keep people safe because I still have scars from what happened. Personal scars as well cuz I went through that whole process myself. So that be cautious of who you’re working with. They’re just trying to close a deal. And here’s the one thing that I’ll, that the evidence that I have to, to show that that’s all they’re about is cuz when you listen to the leadership of those banking entities talking to their loan originators out there selling these these products says all you’re doing is after they tell ’em, hey, you’re getting people into a better deal but you’re also creating your refinance business for the future. They’re churning you. They can’t wait to turn you and that’s where you lose. You want to get more information about that. Talk to me, I’ll show you where you lose refinancing every four to five years.
They stick to you pretty hard. The other thing that you need to be cognizant of is what were your real focus needs to be on the real estate itself. You need to be looking at two things and two things only when you’re buying investment in real estate. Can you keep it reasonably rented the entire time you own it? And can you raise rents? That’s it. If you can accomplish that. Now there’s a third one that gotta keep the maintenance cost low. You wanna buy something that’s been really, really well rehab or newly built, Get your inspections, that’s a given. Don’t buy something that’s gonna cause your problems. But if it’s a place you can keep it rented for the entire time you own it and you can raise rents on it. The ability to create wealth is huge in that if you question those at all, those two items are in question, you walk away.
Yeah, makes sense. Outta curiosity, is the main reason you don’t like adjustable rate mortgages or arms? Is it because of the unpredictability of the mortgage rate come 3, 5, 7 years down the road? Or are there other reasons?
It’s an absolute forced refi at that point, unless the market goes significantly down. Well ultimately everybody who has a, who has an arm is gonna refinance at some point. They just do mm-hmm <affirmative>. And so you’re cr it’s a, is a business creator for the people who write those loans. The other side of it is, is we have no idea how to predict what it’s gonna be at that point. There’s too often I’m hearing people saying, well just, you know, get a seven year arm, you can refinance it seven years, but that’s a standard cycle of seven, right? Or at least an extended cycle. And we just went through a 13 year run that was completely built by manipulated capital and we don’t know how this is gonna run out. I know we have, we have theories and we have, we have speculation on might have, but we have no data to prove exactly how this is gonna play out.
So since we don’t, I think that a person’s putting themself at risk by getting something that feels good for the first couple of years just to come. Having that year seven looming overhead. Now I’ve got an investment property like that. I can’t do anything but five year deals because it’s because it’s a commercial property man. I’m coming up on that five years and it sucks and I didn’t, it it felt like five years wouldn’t come very soon. It was like that five years came really quickly and it’s gonna get ugly. My, my, it’s going up by two points when I go, I go to when I have to renew this deal or I pay it off one of the two. Luckily I have a really, really low note on it. But that’s the, that’s the things we’re talking about here. You think seven years is a long time, seven years is fast and we don’t know how this market’s gonna react. Those cycles could come and it could be really, really devastating.
So let me paint a quick scenario. This is an example and, and some investors go through this. They’re looking at a more higher priced single family home new construction property. Okay? So we’re talking new construction now if you budget in vacancy allowance and you budget in maintenance and repairs, you’re looking at a number on your cash flow that’s essentially, you know, break even zero could be slightly negative, could be slightly positive, but it’s new construction. When you don’t factor in maintenance and repairs, you know you’re positive. Nothing’s super sexy. It’s not a high cash flow or high cash on cash return. But the way some investors like to combat that is to get a lower rate with either an interest only loan if they can get it or an arm, an adjustable rate mortgage for 3, 5, 7 years, maybe even 10. And that just gives them, for the short period of time that three to five, seven year period positive cash flow And over that period of time they theoretically can’t raise rents, increase their cash flow and then down the road refinance hopefully to a lower rate but refinance nonetheless at a time when they supposedly have higher rents that can service the higher debt service from the refinance assuming that rates went up.
So, you know, that sounds like a sound strategy and it works out many times but sometimes it won’t or can’t because rates go up. Someone in that scenario, do you still talk them out of an adjustable rate mortgage? If so, why? Because for some people that’s just the way to keep that property cash flow neutral or cash flow positive short term like over the first three to five years until they can raise the rents and increase the value in the property and refinance.
Well you said a key word in that. That whole description was hopefully when it came to the rates coming down, what I tell ’em, I, I just explained to ’em my philosophy in my business. I don’t talk them out. I tell ’em this is where I see it. And you, you can make a decision for yourself. You’re the CEO of your real estate investment business, but hope is never a good business strategy. You need to be able to lay out your plan and be able to follow your plan. And if you’re hoping for something down the road, I don’t know that hope is going to always gonna pant out. So it can, sometimes it’s a 50 50 shot in reality actually I think it’s really a lot lower percentage for it to getting better from getting than getting worse. Giving the state of our of of how things are in our world, especially at global economy, that things can be influenced really, really quickly overnight.
So how I look at this is, sure you may not cash bill very, very well for first couple years, but tell me a single business that kicks and is cash flowing, right? Advocate, there’s a lot of businesses since the foundation of time that people create a business, they say you gotta be at it for three to five years before you really start seeing that thing generating revenue for you. You gotta come in with some reserves. The other thing of it is, is this is the only business that you will ever have that’s gonna create other forms of revenue for you. It doesn’t always have to be cash flow. We just talk about about the amortization of the loan. That rights there, there itself with a 20% down, you’re going to see a 10.25 average increase year over year of your 25, 20% down because of somebody else paying off the note that tenant.
That’s why I say it’s important to have a property you keep reasonably rented for the entire time you own it. And so even if you don’t bring in a single dollar of cash, but hopefully not have anything pushed out and you may have to have some so that 10.25 might come down to like eight or whatever for a first little bit until it equalizes. The other thing is the depreciation you can play into. There was a lot of deals over the last 10 years that it was a really high price. I seen these fourplexes back when we had interest rates in the threes and fours and they were buying these fourplexes score the floor and $500,000 they were not gonna cash. And how were they sold? They were sold as a depreciation play. That place still exists. That has not gone away. So you need to consider the depreciation capability, what you can keep of your money, the money you earned on your tax return because you bought this real estate.
And look at that at how that influences your so-called cash flow. There’s a lot of other things we need to take in consideration. Now you have the appreciation part of it, there’s an appreciation play, a depreciation play and there also the amortization of the loan. That is hun that can be hundreds of percent return when you really dig into it and not get so focused on the cash. On cash. If you’re not coming into this without some reserves in today’s environment, you may not wanna start playing yet. You want to get those reserves in place. Cause I can’t guarantee you’re gonna be a cash flow heavy person out of the gate. I get a lot of people complaining that hey, I’m only getting 2% cash on cash return outta the gate. But what’s your five? You’re five, you’re looking at a nine. Well five years from now at a nine and then it’s compounding from there. And then you put yourself in a position where you gotta refinance because you took a seven year arm and the rates could be higher and you push yourself from a nine back to a four. Doesn’t that sound like a really stupid move?
So at what point does a negative cash flow not make sense? Meaning that you should pass by like pass on the deal.
When if you don’t have the capability to sustain a negative cash flow for a little while, if you’re a person’s coming in there and you’re barely really getting by on a monthly basis in your personal life and you don’t have the cash flow to do extras, but you wanna be a real estate investor and take money out of your 401K or IRA and go be a real estate investor, you don’t have the additional cash flow to supplement that while you’re getting defeat underneath that business and make it working correctly. Then you may not want to get into that quite yet. You may wanna stabilize yourself first before you start going into expanding a business. Real estate investing is not as passive as we want it to be. Real estate investment is a second business. You’re the CEO of another business and if things don’t work, you can’t blame everybody else.
You’re the one making decisions. So understand what you’re getting into and understand every business out there. You can’t go open up a a convenience store and expect yourself to be cash flow day one. It doesn’t work that way. You can’t open up a franchise and you cash flow day one. You have to build your business up and you have to get the right people in it. I’m telling you that it’s you. Just because we’re not in the market that we were before doesn’t mean there’s not awesome deals out there. Yeah. You just have to approach it the right way. And if you’re expecting everybody else out there to drop everything that’s happening just to make this higher price, higher price property work, you’re doing it
Wrong. Right? There’s always deals out there. I like to say that it’s not a question of when to invest in real estate, it’s where to invest in real estate. If you know the markets, you know what to look for, you’ll always find it because there’s always opportunity in the different markets, the hundreds of markets around the United States. So I guess just to close the loop on what we were just talking about, it sounds like that negative cash flow is okay for a short period of time. Call it one to five years, understanding that rents will rise over time, an average of X percent and those rents will catch up to the point where now you are not break even or negative cash flow. You are going to be positive cash flow and that cash flow will continue to increase. So your cash on cash return will continue to increase. Meanwhile, you have all the other benefits that we’ve talked about with the real estate such as the, you know, the equity growth and the depreciation. Is that a fair summary of what you’re talking about?
That is a very, very fair summary. And I like what you’re talking about the location. There’s a, there’s a reason why they came up with the the term where real estate is location, location, location. People too often people equate that the wrong way with you just to point out another way that they should be looking at where are you buying your investment properties that will stay reasonably rented for the entire time you own it. You can raise rents on that is entirely location dependent.
Yep, for sure. Yeah. Well, I like to say I’ve trademarked the phrase live where you want invest where it makes sense, which means you have to be market agnostic.
A hundred percent. A hundred percent
Perfect. Well let’s just wrap this up. Is there any advice you’d like to give those listening here today about investing or investing, you know, in the near future?
Definitely do your math. Quit taking the simple route of cash on cash return. That’s the simplest equation in the deal. Ignore that equation guys. Do your math, especially on the ability to raise rents, talk to the people in those markets. Understand what those markets will sustain. If they’ll sustain a 6, 7, 8, 9, 10, 12% rental increase year over year. Knock it down a couple points and see what that does for you. If you’re doing a thousand dollars a month on a property, let’s say you’re only making $50 a month cash flow, you’re not gonna get excited about that. You’re charging a thousand but you’re only making 50 bucks. But if you raise it 5%, that’s 50 bucks the next year. You could literally be doubling your cash flow year over year with that. Now the next year you might, you’re going from 1,050, you raise again 5%, you’re not gonna double your cash flow, but you’re can still get double digits.
You can get double digit compound increase on your cash flow every time you raise rents while your per your principal interest, taxes and insurance stays exactly the same for 30 years now. No, excuse me, your principal and interest your taxes, insurance can’t go up, but the principle and interest will stay exactly the same for 30 years. The others can adjust, but you’re getting large percentage increases in your cash flow. You gotta run the numbers out guys, run it out for those first five years and see where he at. Expect to run some negative for the first five. That’s the way it’s always been. It’s been that way since the dawn of time except for the last 13 years. You can’t take the last 13 years as a way to become a real estate investor and engage everything that way going forward. It’s gonna be different and this is where the real people are gonna be able to go out there and play and we’re gonna get all the spectators off the field.
Yeah, I guess to tie a loop on that, I did an episode and I encourage those listening here to go back and listen to this. If you haven’t listened to it for a while or if you’ve never listened to it, I, I did an episode called The Real Returns of Real Estate Investing back in October of 2020. So about two years ago, almost exactly two years ago. It was episode 299. And the takeaways of that episode is firstly, real estate is a multidimensional investment. There are many factors to, it’s not just about the cash on cash that we were talking about. There’s the depreciation, appreciation, amortization, you know, the leverage. It’s truly a multidimensional investment. Two, don’t get focused or hung up on cash flow alone, especially in the beginning, which is something we’ve talked about here, you know, at some length. And thirdly, is focusing on cash flow alone can be shortsighted because there is such tremendous ability to build wealth through that equity growth a little bit in the beginning, but it accelerates quickly as the years go by.
And if you lose sight of that piece of it, then you’re losing sight of one of the greatest wealth creating opportunities that real estate provides you. So I encourage everybody to go back and listen to episode 299, The Real Returns of Real Estate Investing because I actually break down using a spreadsheet, a detailed spreadsheet of the actual returns in real estate investing year by year by year, and compare the cash on cash returns and the cash flows versus the equity gains and how they compare in terms of percentages. So it’s, it’s kind of a deep dive into the numbers and how they unfold over time. So any last comments, and we’re gonna draw this to a close here.
The last couple episodes we did together, we talked a lot about that same thing too, and I gave you, gave some of the equations to look at when you’re looking at the how to amortize the loan and how it’s gonna give you those great returns. So it may be worthwhile we get to go to the podcast. It was just talked about the last two I did with Marco to, to also button some of those things up that we talked about here. I take for granted that people understand these things because that’s routed around in my head. Reach out to me if you want aaronchapman.com. I’d be more than happy to settle, spend some time going over the calculator with you, how to really, really focus on, on growing your real estate investment business in an environment. The rather where the scared people are not gonna be in your way, they’re not gonna be bidding and, and pushing your price up on you.
Yep. Well, perfect. You answered my question about your contact information, so there it is. Well, Aaron, thanks for coming on the show today. It’s always great chatting with you. We’ll have you on Right on buddy.
All right. Thanks man. Always good to see you.
You too. And for everybody else listening, remember that you can contact my team of investment counselors if you want to talk about your investment strategy, where you can go, what’s available around the country. We’re always here to help you. If you have a question about real estate investing, shoot it on over to me. Go to passiverealestateinvesting.com. Remember to subscribe to the show. Help us spread the word, share the show with your friends, family, and other like-minded individuals. Thank you for listening and we will see you all on our next episode.
Download your FREE copy of: The Ultimate Guide to Passive Real Estate Investing.
Get your FREE coffee mug by leaving us a Rating and Review on iTunes. Here’s how.
See our available Turnkey Cash-Flow Rental Properties.
Please give us a RATING & REVIEW (Thank you!)